Structured Equity Derivatives - Essay Example

Leverage on equity returns over predetermined ranges. Limit or reduce downside exposure to the underlying equities. Even out, compensate or reduce transaction costs as part of multiple option sophisticated investing strategies. The term equity derivative essentially means a class of financial instruments whose value is at least partly derived from one or more underlying equity securities. Market participant's trade structured equity derivatives in order to transfer or transform certain risks associated the underlying.

Options are by far the most common equity derivative; however there are many other types of equity derivatives that are actively traded. Ramaswami et al(2001) have lucidly described the concept of structured equity linked derivatives through the concept of Equity Linked Notes(ELNs).They state as follows, "An Equity-Linked Note (ELN) is an instrument that provides investors fixed income like principal protection together with equity market upside exposure. An ELN is structured by combining the economics of a long call option on equity with a long discount bond position.

The investment structure generally provides 100% principal protection. The coupon or final payment at maturity is determined by the appreciation of the underlying equity. The instrument is appropriate for conservative equity investors or fixed income investors who desire equity exposure with controlled risk". The figure below explains the profits at the expiration of a fully protected ELN .Current Industry Scenario Since their launch on the London Stock Exchange in 2005, Listed Structured Products have become popular and flexible investment tools for UK wealth managers and brokers.

In there simplest form, they offer ETF like access to underlying that may be otherwise difficult or expensive to trade, such as commodities, emerging markets or property indices. The more structured products, such as Accelerators, provide enhanced upside participation with no worse than market risk. In addition they can reduce other risks, such as eliminating currency risk for non UK investments, or provide an element of capital protection in case of market falls. Another range of products are designed for Income seeking investors.

These can offer high annual (or semi-annual or quarterly) coupon payments in return for giving away upside market participation. All Listed Structured Products enjoy the benefits of being traded directly on the London Stock Exchange. These include: Transparency:Live, two-way prices are maintained throughout the trading dayEase of trade:Products trade and settle via CREST as with UK equityLiquidity: Trades of 5m+ can be executed at prevailing market pricesFlexibility: Min trade size of 1,000 makes products highly accessibleKey Terminology:1Trackers:Tracks an underlying asset (commodity, Halifax house price index, equity indices etc) Cost efficient means to trade an asset Diversify exposure across an index Stamp duty free Typically long-dated or indeed undated with an indefinite lifespanReverse Trackers:An inverse relationship with the underlying asset Profit from downwards price movements in the underlying Stamp duty freeCapital Protected:Exposure to underlying asset at fixed percentage Capital invested is protected at specified level Stamp duty freeYield Enhancement:Track underlying instrument without leveraged downside Can incorporate many different features which affect